Hold on equity investors – and look to Asia, if some are to be believed. There is general unease among investors ahead of this week’s FOMC meeting. But that amounts to mere surface jitters compared to more substantial concerns about the approaching end of the “bear market rally” – or whatever you want to call the recent upward trajectory of equities in markets around the world.
Indeed, the prediction de jour among pundits is an end to what CLSA’s Christopher Wood calls the “global equity counter trend rally”. But, warns Wood in his latest Greed & Fear newsletter, don’t “bet aggressively” on this view in terms of shorting markets on a leveraged basis, since the base case remains that the rally peters out later this summer with a S&P500 target range of 1,000-1,050.
Still, if Wall Street correlated equities are to correct, the sell-off is likely to take the form it did last summer, being led by a decline in oil and related commodities, a rally in the dollar and in US government bonds. In this sense, he notes, renewed confirmation of deflationary pressures in the west “still has the ability to unnerve equity investors”.
In Wood’s view, dollar debasement or debt default – “or some ugly combination of the two” – cannot be ruled out in the medium term while ownership of gold remains an essential form of insurance, to “hedge the systemic risks caused by the panicky response of Western policy makers to growing deflationary pressure”. Understandably, Wood – CLSA’s Asian equity strategist – sees Asia and emerging market asset prices as the biggest beneficiaries of monetary easing in the west. There is, he says reassuringly, a real possibility that Asia can “enjoy an asset bubble before the Western fiat paper currency system finally implodes”.
That said, Asian stock markets will still be correlated the next time Wall Street corrects meaningfully, he warns. The hope this time, however, is that “Asia will be considerably more resilient on the downside” than it was in 2008 given the clear evidence of domestic demand resilience in China and India.
Even if Asian markets head higher over the next two months, with oil making one last surge to the $80-$85/bbl level and the S&P500 to the 1,000-1,050 level, any subsequent correction is likely to take Asian equities below present levels. And that, in Wood’s view, is because Asia is “still about incremental decoupling and not yet full-scale decoupling”.
As for the next deflationary scare, keep watch on events in Europe rather than America, he warns – particularly on Latvia, where the euro-linked currency peg creates the potential for a catalytic news event that could cause increased currency volatility as well as sovereign defaults. Even so, in Wood’s view, there is unlikely to be real collateral damage in Asia given the vastly different macro-economic conditions.
KBC’s Jonathan Allum, meanwhile, noted in last Friday’s edition of his daily newsletter The Blah that the latest Merrill Lynch Global Fund Manager Survey showed that as economic optimism rises, asset allocation shifts, although the latter still lags the former. For the first time since 2007, the survey suggests that global fund managers are overweight equities, although the net 9 per cent is “far from overwhelming and is less than the net 12 per cent who are still overweight cash”. Geographically, the principal expression of this optimism is an overweight position in emerging markets, although this has slid from May’s net 40 per cent to 37 per cent in June.
Interestingly, the survey also finds a high optimism quotient, with 62 per cent of survey respondents saying the world economy will improve in the next 12 months, an increase of 5 percentage points since May. A mere 7 per cent see global recession in the coming year – a huge change from the net 38 per cent who believed the recession scenario in May and a net 70 per cent in April.
However, as Asian Investor points out on Monday, the survey also found that global emerging markets remain the most sought-after market globally for equity allocations, with 37 per cent of respondents overweight in global emerging markets. But, warns AI, there are indications that the euphoria surrounding emerging markets “might have peaked” because, in May, 40 per cent were overweight in global emerging markets. In addition, 10 per cent of respondents now believe that global emerging markets could be overvalued.
Allum makes two further points about investor optimism:
One is that it is very Sinocentric. To quote the Merrill Lynch press release: “Investors are rewriting the rules for positioning their portfolios at the start of a new investment cycle. Rather than focus on moving from defensive to early cyclical stocks, such as consumer discretionary, they are basing their strategy around optimism over Chinese growth”.
(Given this huge focus on China it is “just as well”, says Allum, that the World Bank [last Friday] revised up its 2009 GDP forecast for the Middle Kingdom from 6.5 per cent to 7.2 per cent).
The second is that optimism is broadening from the economy to corporate earnings with a net 49 per cent of respondents expecting the profit outlook to improve over the next 12 months. It seems increasingly likely that current profit forecasts, in Japan and elsewhere, are just too low.
Looking overall at Asia’s prospects, Nomura in its global weekly monitor sees growing distinctions: “China recovering first; India, Indonesia and Vietnam showing resilience; and the rest lagging”.
Helped by stimulus and “domestic animal spirits”, a strong recovery is underway in China, it notes, predicting growth of 10 per cent in 2010. In Korea, the economy should bottom out in Q3 2009 and the central bank should start hiking rates in Q4 to contain inflation expectations. As for India, economic recovery should take hold in the second-half, and with a pro-reform government, the outlook is bullish longer term. In Australia, a mild recession looks likely as very expansionary policies help offset the impact of households retiring debt, while Southeast Asia offers “no clear signs of economic recovery, except for Vietnam”.
As for Japan, Nomura expects the government’s latest stimulus measures to provide a temporary boost to the economy, but not to trigger a full recovery before the second half of 2010. Watch, says Nomura, for the Bank of Japan to re-start quantitative easing and increase its outright JGB purchases again by the end of this year.
Related links:
Emerging markets : A golden era or booster over-hype? – FT Alphaville
Latvia – more parallels with Argentina - FT Alphaville